March Newsletter 2019 Part II

The  2019 IPO Siege Starts Today--How should we play it?


Dear Subscriber,

Here we go-- what a wild and wooly end to Q1 2019!

#1 The slowdown we expected in US economic growth from Q4 2018 (2.25%) to Q1 2019 (1.2%)is on target and Q2 GDP looks like 1.45% now too--where's the 4% secular GDP tax cut miracle? 
As I shared this time in 2017--what a crock of economic shit.  
#2 First quarter one-year US inflation rate is NOTHING and reported again under 2% at 1.5% annualized--The current inflation rate for the United States is 1.5% for the 12 months ended February 2019, as published on March 12, 2019 by the U.S. Labor Department. 
#3 Our Transformity Macro Market Index ends the quarter 15.5--BULLISH. Less than 4% chance of recession by year-end with the Fed "put" coming soon. 
#4 Our Transformtiy Investor PRO portfolio growth in Q1 2019 with dividends paid is up over 29%
--for the quarter! That is the best quarter we have ever had since our start in 2013. We are outperforming the S&P 500 Index by 2.3X or 230%--ho hum!
#5The Fed has quit raising rates -- QE ends in September--the next move with no inflation and with a 5.5% effective shadow Fed Fund rate makes the next FED MOVE a 25-50 basic point CUT! The "shadow Fed Funds" rate and risk assets told us the Fed would do this in October AND that they made a big mistake raising rates in October and December. I agree with Stifel's Barry Bannister that I follow closely "We know the first quarter is weak but if it continues into the second quarter, that's going to be evidence that the market was right back in the fourth quarter. The problem the Fed has is it's kind of a chicken and an egg. They're going to have to see some eggs broken in the economy before the Fed goes chicken," he said. Bannister said two rate cuts could be appropriate based on his forecasts for a weakening U.S. economy. He anticipates disappointing inflation, slower nominal and real growth, continued weakness abroad, and a failed retail revival. CONCUR!

#6 The market has priced in a "Trump Victory" in his China Trade War--China has to have it to avoid virtual recession and Trump's 2020 re-election hopes require it. I look for a "sell the news" event when it is announced.
#7 The 2019 $Billion Tech Unicorn IPO crescendo has started with Lyft (LYFT) and $2 billion raised and no hope of ANY profits for 8-10 years based on the prospectus (unless "driverless vehicles are deployable ahead of our technical and regulatory projections"). $100+ billion of cash money is going to have to go out of the last shiny object aka FAANG stocks and some richly valued big cap cloud software stocks IMHO to chase the new shiny objects in the stock market. But just like the IPO crescendo 1998-1999 (that I remember so well as a large shareholder of which had $30 million in revenue and 6 million share float as ran to $110 and a $billion value in the greatest one-year wealth creation and destruction event ever--yes I DID sell most near the top!)

Note: I have not been talking much about the "shadow Fed Funds rate"--but we use it in our Transformity Research Macro Market Timing here is a quick explanation. 
What exactly is the shadow Fed Funds rate? This measure was created by University of Chicago academic Jing Cynthia Wu and Merrill Lynch's Fan Dora Xia to more accurately measure the impact of monetary policy at the so-called "zero bound."  Zero bound means when central banks took policy rates to 0% and below following the financial crisis and used the never before new monetary tool aka quantitative easing (buying $4 trillion of bonds from bond dealers with "electronic cash" used. instead of real cash deposits. ) The Wu-Xia shadow rate was an effort to capture these unconventional efforts into a truer measure of where policy rates actually were.

By this measure, the Fed's shadow rate hit a low of -3% in May 2014. It has since risen 6.7% according to calculations by Societe Generale, driven by the slow drawdown in the Fed's balance sheet as years of mortgage and bond purchases are reversed. Assets mature, principal balances are repaid, and cash is repaid to the Fed and taken out of circulation.

Why Is It Important? It is important now because the Fed minutes now say the shadow rate matters and they FOMC uses it to make monetary policy.  It means that with GDP Q1 retracting to 1.5% range, the shadow rate has told the Fed that they OVER tightened in October and December--and that tells us that the next Fed move is to LOWER rates to keep the expansion alive. Look at these charts


The "green color" in this shadow rate chart is what the total monetary stimulus effect is including the Fed Funds rate. You can see nearly 85% of the Fed's stimulative monetary has come from its QE portfolio and much less from it's Fed funds hikes. Remember all monetary policy operates with a lag of about nine months. So even though the Fed slammed the brakes on rate hikes, in December and now March 2019, and will end portfolio run-off in September, further shadow monetary tightening is coming anyway because of the lag. The market is pricing in the first cut to come as soon as September, with about a 25 percent chance of another decrease before the end of 2019.

Key Point: This confirms that once again the BOND market had GDP deceleration and benign inflation right and made the right call to go long bonds in October

The chart tells us why. With Fed's policy funds rate (this is the rate it costs banks to lend to each other) currently set in a range between 2.25 percent and 2.5 percent the shadow Fed Funds rate (that takes in all the reduction in cash and bonds at the Fed) is about 55.5%. It was 4% ish in October when the Fed said they were "a long way" from a neutral non-stimulative monetary policy and near 5% at the 2018 year end.

Well--the GDP collapse from 3.4% in Q3 2018 to 1.2% in Q1 2019 (and an estimate of just 1.45% in Q2 2019) says the Fed is now closer to cutting its 2.5% rate than raising. For context. 45% of sovereign bonds are still at negative interest rates and the EU, German 10-year bonds are still barely above 0% and Japanese bonds are still below 0%.  In talking to my old DC pals at the Fed (the Fed subscribes to this newsletter and my previous one ChangeWave Research) they agree with me on splitting the Atlanta and NY Fed "Now Cast" GDP forecasts (now at 1.25% GDP in Q1 and 2.2% final reading on Q4 2018).

Why do we care/Action To Take:  We are heading back to accommodative Fed policy & 2% GDP 2020 in a late cycle hurrah--that means companies with 20%+ rates of profitable growth out 2-3 years get a HIGHER price earnings ratio bump (meaning P/E expansion as those future profits are going to be discounted at a lower rate).  Nvidia, AMD, Xilinx, Chegg are still LONGS and we will add 4-6 more to balance out our Ultra Income plays.

ACTION TO TAKE: We are going to HOLD two MRRL positions since it lags MORL. I am putting in a $14 sell stop. Many of you I know stepped in during the late December 2018 flash crash under $12--those are sweet yields!  Some brokers are not accepting MORL orders since it is not adding new shares. I LOVE that as a MORL shareholder--it makes MORL sell at a premium to its mortgage bond portfolio. BUT---if the sponsor does not re-open MORL shares, we will look to close them too. NOTE: IF you are long MORL like many of us are under $12--I would NEVER sell them as your yield like our OG BDC Newtek shares from 2014 (which I still hold as well) deliver cash-on-cash yields you can NEVER  dream of replacing.


Make sure you are evenly weighted between SECULAR growth companies at reasonable valuations and 15%+ Yielders that do well when short term rates are going down.  We are adding Bloom Energy (BE) as a broken 2018 IPO that has 40-50% revenue and earnings growth locked in through 2022 with 2X upside by end of 2020 and will add another broken high yield MLP that is converting to a REIT with 40%-50% upside (that Alert out Monday). 

We will add some options in NVDA XLNX (the new Nvidia) and AMD next week to. But let me share a phone interview with Barron’s on Tuesday with my old technology guru (he worked at Nvidia as an engineer for 10 years) ARK Invest technology analyst James Wang explained why A) Apple’s new services strategy is worrisome. He also gave his appraisal of Nvidia ’s (NVDA) recently announced acquisition of Mellanox and handicapped the big chip war between Advanced Micro Devices (AMD) and Intel (INTC) this year.

Jimmy Wang is a technology analyst focused on artificial intelligence and internet companies at ARK Invest, an investment firm with $6 billion in assets under management. Previously, he spent nine years at Nvidia as a product manager and analyst. He is the most insightful engineer I follow. 

In addition to Apple, his firm also owns shares in Nvidia, Netflix (NFLX), and AMD. You can find James on his Twitter feed @jwangark.

Barron’s: What did you think about the Apple Services event? The content strategy?

I thought this is one of Apple’s weaker events from a presentation and narrative perspective. But if you look at it from an end-user perspective, none of these services are super-compelling and differentiated versus competitors. (AGREE).

Apple’s original DNA was built upon building products that other companies couldn’t build and bringing to market something that was much, much better and better thought out. I think it’s very hard to argue that any of these products are better thought out and better rounded than existing products from Netflix and Spotify (SPOT). (100% AGREE) 

 I see them trying to really satisfy Wall Street and demonstrate the financial model, on the other, I am somewhat concerned that they’re losing their core DNA, which is to build great products that don’t exist, to create markets, rather than compete in markets. (200% Agree)

You are saying these services offerings are Wall Street driven, not consumer-need driven?

Yes. Absolutely. I don’t think a consumer is asking for a different kind of credit card or a credit card where it’s made of titanium but has no number. I can see so many issues already using it in practice, but Apple, of course, the company that gave us the dongle apocalypse situation with the iPhone and iPad, is sometimes very boneheaded in their ways.

What about your thoughts on Apple TV+? Will it be a viable competitor to Netflix?

It’s not even ready. We barely got it. The event was supposed to demonstrate how that was going to work. The pricing and the content partners, we didn’t get any real information on any of that. So it feels very rushed and we have no more information even as investors to assess whether or not it’s going to competitive versus Netflix and the others.

What is the current competitive landscape for AI? How will it develop and what are companies that will be the long term winners?

Two years ago, the leader was Nvidia and there were a huge number of start-ups that were developing specialized ASICs to compete with Nvidia in AI. I think [start-ups were] a concern from a competitive perspective, certainly for investors like us, and I’d been kind of monitoring them. So far Nvidia is out-executing them. Nvidia has really closed the architectural gap and that’s made the competition a lot harder for the start-ups. Meanwhile, if you look at the start-ups, they haven’t actually shipped silicon in volume at all. I feel better now about Nvidia’s competitive position than a year and a half ago.

Comment:  Our research says the crypto-hangover is over for Nvidia GPU chips--based on the aftermarket price rise in the last 20 days. 

What are the key issues and risks concerning Nvidia’s acquisition of Mellanox? Will it work?

[Nvidia’s] prior acquisitions were not hugely successful and didn’t achieve the strategic goals that [Nvidia CEO Jensen Huang] set out. This time I think it’s clear it’s all about the data center. And Mellanox is known for the interconnects that will kind of weave together different servers, so they can behave as one large server, aka supercomputer. I think that’s a good vision. It is not clear and Nvidia has not made it clear why they needed to acquire as opposed to partner with Mellanox. Jensen’s answer is we are not very good at partnerships, to get really deep integration we need to acquire them. That may be the case, but that’s a very, very expensive price to pay for something that is that you could maybe work through [in a partnership] if you just tried harder with integrations.

In my opinion, at least 50% of the reason for the acquisition is defensive [versus Intel]. It may or may not be transformative for Nvidia. It won’t be a bad thing in any case. But if Intel had acquired them, I think it would have been very bad for Nvidia.

What are your thoughts about the big AMD versus Intel chip war later this year?

I think AMD has a pretty good road map bet on that. Probably the best server-chip road map they’ve ever had. The last time they were in this position they didn’t quite have a road map. They just had kind of two good chips and then Intel caught up. But now I think AMD has an opportunity to take maybe 10 to 20% of the server socket from Intel. If that happens, it will be pretty transformative for the company. But Intel, I think, has been kind of "woke" up from their slumber and they are gearing up very, very quickly to respond architecturally. This is for the first time that AMD has had a [chip manufacturing] technology node parity with Intel with TSMC (TSM) kind of catching up to Intel. So there’ll be fighting on equal ground and we’ll see under Lisa’s [AMD CEO Lisa Su] leadership if AMD can [get an] advantage against Intel.

New IPOs bring Eyes to Busted IPOs

Action to Take: Buy BE Bloom Energy under $14 with $28 Target.

BE is a large Beneficiary of Climate Change/PGE Bankruptcy/Clean Energy Credits & LOWER Cost Electrical Power that goes 24/7 in Floods, Firest, Snow Storms All Over the World 

From the CEO: "Our value proposition is more and more relevant every day to our expanding customer base. Commercial and industrial companies experienced more and longer grid power outages than ever before in 2018. Many now also face the prospect of higher rates as the cost of protecting overhead transmission lines from escalating extreme weather events must be borne by rate payers.

Nationwide, the U.S. also saw an increase in energy-related CO2 emissions for the first time in several years. Our mission to deliver clean, affordable, resilient, Always On power for the world has never been more relevant. All of these factors and our own strong business performance helped propel Bloom Energy to a record year in 2018. In 2018, we grew acceptances (the number of their nat gas or waste gas energy power systems deployed and generating revenue) by 30% versus 2017 and delivered full year revenue of $742.0 million, up 97.4% yearover-year including the benefit of the investment tax credit. 

We continued to drive down the cost of our existing commercial platform in 2018. At the same time, we are ramping R&D efforts on our next generation platform which will deliver 33% more power in the same physical footprint and provide a further basis for cost-down. Lastly, we ended 2018 with new orders spanning multiple countries and a highly diversified set of industries, including data center/cloud services, healthcare, retail, hospitality, advanced manufacturing, higher education, real estate, government and (dozens) of US and international utilities."

I am also a long time shareholder in Bloom Energy from a VC fund that I am in that held shares. The stock IPO's at $18 and doubled to $38 in one of the weirdest "No News" melt-ups I have ever seen. I sold my non-locked up shares and said "Huh--what the heck happened".

Turns out later (when short positions and real float numbers came out) is was a classic low float short squeeze.

The stock then cratered of course below my $28 valuation and kept going to $8 in the December flash crash. 

Then I got interested again.

My interest is #1 Their next iteration of the "Bloom Energy Server" comes out in a few months and is 33% MORE efficient per kilowatt. That makes it lower than utility power in many parts of North America and the world with zero power outage risk. Then the next iteration will be 25% ish lower in cost simply because of scale economics. They own 100% of their patents--they have the best fuel cell technology team in the world--and there is $2 trillion of pension fund money that HAS TO build a position in "zero carbon footprint" energy for PC and sustainability investment rules they must follow. 
#2 There are  big 15% tax credits till at least 2023 for US and CA buyers that make the server cost (which now can 100% be expensed too) + credit an incredible value proposition for many many countries and industries
#3 It turns out that huge energy-intensive national pension plans like Alberta Canada, Norway, Kuwait and California Teachers Pension Fund are required (based on their sustainable investing rules) to lower their exposure to carbon energy equities and get to 5-8% of their equity portfolio in "sustainable zero carbon footprint energy equities. For example, on the last day of Feb 2019, the Calgary Pension Fund had to disclose they bought 5% of the outstanding shares of Bloom Energy into the meltdown. THAT took a lot of the float out of the stock. Similar disclosures are made by other "significant shareholders. 
#4 Bloom is working on the "Home Energy Server" the size of a laser printer that would cut my power bill by 50% in high-cost areas like Arizona.  Take me off the AZ power grid cartel? I'm ALL in --and in California and other Blue states you could count on tax credits too. America is awash in fracking nat gas--new pipelines open this year and next that bring a huge supply from PA and the Marcellus Shale to the East Coast. The lower the cost of nat gas, the lower the operating cost of a Bloom Server 
#5 Just about every city and certainly every county has a landfill that generates trillions of cubic feet of methane annually. Bloom's newest energy cells run on that methane an address a hundred plus GIGAWATT opportunity for landfills to monetize their zero cost methane. Just the landfill opportunity is a $multi-billion annual opportunity in California alone. Worldwide? Literally inestimable. But in a carbon-sensitive world (ex-United States) --the methane-powered Bloom Energy server is like an energy source that never stops and with endless landfill methane--the opportunity is mind-boggling. 
#6Finally the blown-up stock got over and stayed over its 50-day moving average on decent volume. The stock can run to $16-$18 very quickly because of the low real float of the stock--which I estimate at of the 40 million shares in the "float" the real float--meaning shareholders who are not locked into owning shares because of pension plan rules--is more like 20 million shares. The stock trades 1 million plus shares a day--that is why it makes these violent moves. 


My valuation at $28 is simply Bloom getting to $2.5 billion run rate in annual revenues by 2022 and a normal 7-8X multiple on their free cash flow. 

Net /Net--I LOVE great secular growth stocks with broken IPOs--once they get their mojo back they can move up fast and make us a LOT of money.

Let's take advantage with little downside now and lots of upside in Bloom Energy (disclosure--I still own 5500 shares from my VC fund disbursement and will look to add more on any pullback). 

Final Point

Since 2009, the American stock market ( and European banks) has been levitated by the amazing monetary response of the Federal Reserve bank and the amazing technology disruptions pioneered by amazing American companies. When the Fed made cash "trash" and increased financial asset values to stimulate the Great Recession aftermath, those of us in the investor class and homeowner class a financial gift of historic proportions.

Easter and Passover are coming--I strongly encourage you to give a little extra to the folks who work hard but did not own financial assets that exploded 3-4X in value for no fault of their own. We have over 115 million Americans who live in working poverty ALICE households--defined in June 2018 as "Asset Light-Income Constrained-Employed. They need a little help--they are one accident, illness or layoff away from moving in with their family or homeless shelter.

If you have been with us for just a year, you created more wealth in a year than 115 million Americans will see in their entire life. 

It feels great to share and we have plenty in need--just a thought. I just donated some shares to a group that helps Veterans build homes for themselves--I am on cloud nine. 


March 2019 Transformity PRO Performance

Position 3/29 Growth + Div Buy Under Target

AMD 36.00% $25.00 $28.00

AMD 36.00%

Nvdia 34.00% $180.00 $225.00

Nvdia 34.00%

Chegg 34.79% $40.00 $55.00

MORL 25.68% $15.50 $16.00

MORL 25.68% $15.50

MRRL 19.98% $14.00 $15.50

MRRL 19.98%

BDCL 27.21% $14.50 $16.00

BDCL 27.21%

NEWT 1 8.25% $19.00 $22.00

NRZ 26.18% $16.00 $18.00

NRZ 25.18%

MIC 18.27% $42.00 $55.00

MIC 18.27%

SMHB 9.89% $22.25 $25.00

AMZA 6.20% $6.00 $8.00

Total 28.45% SP 500 12.3%

Total Transformity Pro Market OutPerformance To Date: 2.3X or 230%